Australia’s turn to face fiscal reality

News that United States President
Barack Obama
and Senate leaders have come to an agreement to try to avert the American government falling over the fiscal cliff is a good sign for the global economy as the new year kicks off.

The agreement was too late to avoid the fiscal cliff deadline, but Congress can pass backdated legislation which will stop tax increases and spending cuts from coming into force.

However, the US deal – which is not guaranteed to pass the House of Representatives but has been passed by the Senate – does little more than trade off a comparatively slight increase in the tax burden for the very rich, for further talks on spending cuts which must be resolved within two months. It is a tepid agreement that puts off, again, the day of reckoning rather than resolves the crisis.

The US fiscal cliff, a term coined by Federal Reserve governor
Ben Bernanke
, involved across-the-board tax increases and spending cuts to government programs that would be triggered when the government reached a debt limit of $US16.4 trillion and if Congress and the White House could not agree on a deal by January 1. The combination of the tax increases and spending cuts was likely to send the US economy into recession.

Under the latest agreement, taxes will remain steady for the middle class but increase for individuals earning more than $US400,000 a year, and for couples earning more than $US450,000. Taxes on capital gains and dividends will also increase, although again only on those earning more than $US450,000, as will taxes on estates worth more than $US5 million.

A further bonus is that a 2 percentage point cut in the federal payroll tax, a temporary concession enacted two years ago to stimulate the economy, will remain in place.

Despite obtaining some tax increases, the deal is much less than President Obama wanted, as he had campaigned to increase taxes on those with incomes of more than $US250,0000. The Republicans baulked at this.

For their part, the Republicans had hoped to rein in the cost of Medicare and other government benefit programs, but the latest deal settled for further negotiations on cuts to both the welfare and Pentagon programs.

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This will result in another round of brinkmanship two months down the track over where the spending cuts should fall if the economy is to avert arbitrary spending cuts of $US110 billion from the defence and domestic budgets.

The US deal is expected to slow American growth while avoiding plunging the US into another recession. But the semblance of fiscal discipline still leaves the largest economy with a massive deficit. Nor has America developed anything like a consensus on the role of government.

A proper fiscal program would require changes to taxation as well as reform of middle class and business welfare.

Of course, Australia faces its own, albeit milder, version of the fiscal cliff or, more accurately, fiscal gap.

We are coming out of a resources boom when surging revenues meant that almost any government could and did achieve headline surpluses, albeit without attacking structural bugetary issues.

It is true that with a recovery in iron ore prices in recent weeks Australia’s economic growth may be not quite as weak as was expected before we headed into the holiday season. And we don’t have either the massive government debt or the dramatic deadline of the US system.

However, previous lack of fiscal discipline in this country means that our tiny surpluses are set to be killed off by falling revenue and the government’s preference for big-spending programs.

Even during our biggest export price boom Australia was unable to live within its means, and now that the boom has passed its peak the government faces major shortfalls in tax revenue.

Just before the holiday break Treasurer
Wayne Swan
dumped the government’s previous, long-held commitment to a budget surplus. That commitment had produced tiny surpluses that were more the result of accounting tricks such as bringing revenue forward, than strong fiscal discipline.

With the government abandoning its commitment to a surplus, the budget remains in both a headline and “structural" deficit, and is highly exposed to any sharper downturn in commodity prices.

There is no medium-term framework for returning the budget to surplus, and there’s no sign that the government has any interest in either curbing spending or reforming the tax system.

The recent jump in iron ore prices should not give us a false sense of security that we do not need strong budget discipline. Export prices are proving volatile and are more likely to go down than up.

Mr Swan has promised that the government will revisit the budget numbers early in 2013. But unless we tackle the problem of putting proper fiscal discipline in place with five-year planning cycles now, we may well eventually face the massive debts of the US governments.

The US has swerved to avoid the fiscal cliff, for now. But Australia has yet to face up to its own fiscal gap.